Chapter 11, Problem 5BP

1.

To determine

Indicate the market value of common stock of Company S.

Explanation of Solution

Market value: Market value is the price at which, both seller and buyer agree to exchange the security. So, market value is the selling price to the seller and the purchase price for the buyer.

The market value of common stock of Company S is the current stock exchange price, $90.

2.

To determine

Indicate the par values of common stock and preferred stock of Company S.

Explanation of Solution

Par value: The corporation charter assigns and allocates the dollar value for its share which is referred to as par value.

The par value of preferred stock of Company S is $250$\left(\text{375,000 preferred stock÷ 1,500 preferred shares}\right)$ .

The par value of common stock of Company S is $50$\left(\text{900,000 common stock÷ 18,000 outstanding common shares}\right)$ .

3.

To determine

Compute the book value per share of Company S, if no dividends are in arrears.

Explanation of Solution

Book value per share: This is a financial ratio which measures the value of shareholders’ equity available per common share.

Formula for book value per common share:

$\begin{array}{l}\text{Book value per }\\ \text{common share}\end{array}\}\text{ = }\frac{\text{Shareholders’ equity applicable to common shares}}{\text{Number of common shares}}$

Compute the book value per share of common stock of Company S.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	375,000
Equity applicable to common shares		$2,025,000
Number of outstanding common shares		÷  18,000
Book value per common share		$112.50

Table (1)

Conclusion

Thus, the book value per common share of Company S is $112.50, if no dividends are in arrears.

4.

To determine

Compute the book value per share of preferred stock and common stock for Company S, if two year preferred dividends are in arrears.

Explanation of Solution

Compute the book value per share of preferred stock of Company S.

Particulars	Amount ($)	Amount ($)
Preferred stock par value	$375,000
Preferred dividend	60,000
Equity applicable to preferred shares		$435,000
Number of outstanding preferred shares		÷  1,500
Book value per preferred share		$290.00

Table (2)

Working Notes:

Compute the amount of preferred dividends for 2 years.

$\begin{array}{c}\text{Preferred dividends}=\left\{\begin{array}{l}\text{Preferred stock }\times \\ \text{Preferred dividend percentage}\times \\ \text{2 years}\end{array}\right\}\\ =\$375\text{,000×8\%}\times \text{2 years}\\ \text{=\$60,000}\end{array}$ (1)

Compute the book value per share of common stock of Company S.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	375,000
Less: Preferred dividend	60,000
Equity applicable to common shares		$1,965,000
Number of outstanding common shares		÷  18,000
Book value per common share		$109.17

Table (3)

Note: Refer to Equation (1) for the value and computation of preferred dividend for two years.

Conclusion

Thus, the book value per preferred share is $290.00 and common share of Company S is $109.17, if two year preferred dividends are in arrears.

5.

To determine

Compute the book value per share of preferred stock and common stock for Company S, if two year preferred dividends are in arrears and preferred stock is callable at $280 per share.

Explanation of Solution

Compute the book value per share of preferred stock of Company S.

Particulars	Amount ($)	Amount ($)
Number of preferred shares	1,500
Preferred stock call price	×  $280
	$420,000
Preferred dividend	60,000
Equity applicable to preferred shares		$480,000
Number of outstanding preferred shares		÷  1,500
Book value per preferred share		$320.00

Table (4)

Note: Refer to Equation (1) for the value and computation of preferred dividend for two years.

Compute the book value per share of common stock of Company S.

Particulars	Amount ($)	Amount ($)
Total stockholders’ equity	$2,400,000
Less: Equity applicable to preferred shares	420,000
Less: Preferred dividend	60,000
Equity applicable to common shares		$1,920,000
Number of outstanding common shares		÷  18,000
Book value per common share		$106.67

Table (5)

Note: Refer to Equation (1) for the value and computation of preferred dividend for two years.

Conclusion

Thus, the book value per preferred share is $320.00 and book value per common share of Corporation R is $106.67, if two year preferred dividends are in arrears.

6.

To determine

Compute the dividend per share of common stock.

Explanation of Solution

Common stock: Common stock is the cash raised by the company by issuing common or ordinary shares to the stockholders. This is an investment for the shareholders for which they receive the dividends from the issuing company, and have voting rights.

Preferred stock: Preferred stock is the cash raised by the company by issuing preferred shares. This investment fetches a preferential right for dividend for the preferred stockholders over the common stockholders.

Cash dividends: This is the amount of cash distributed to stockholders by a company out its earnings, according to their proportion of shares invested in the company.

Compute the dividend per share of common stock.

Particulars	Amount ($)
Cumulative preferred dividend	$30,000
Arrears in prior years	60,000
Total cumulative preferred dividend	90,000
Cumulative preferred dividend paid	$90,000
Total dividends declared	$100,000
Less: Cumulative preferred dividend paid	(90,000)
Common dividend paid	$10,000
number of common outstanding shares	÷   18,000 shares
Common dividend per share	$0.56

Table (3)

Note: Refer to Equation (1) for the value and computation of preferred dividend for two years.

Conclusion

Thus, the dividend per share of common stock is $0.56.

7.

To determine

Explain the reasons for the book value not being a good estimate of its market value of the common stock.

Explanation of Solution

Reasons: The main reason for book value not being a good estimate for market price is the recording of assets at historical cost, but not the current selling price. So, book value and market value are different. Book value depends on the past transactions but current market value depends on company’s growth, earnings, market interest rate, and government policies.